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Economy: The outspoken governor of Luxembourg’s central bank criticised the lack of economic reform in the Grand Duchy during an event at the British ambassador’s official residence Wednesday night.

The central bank’s latest forecast projects the economy will expand slowly through 2013, Yves Mersh said. While the total number of jobs is the highest ever seen in Luxembourg, the figure has not kept up with brisk population growth, he explained. In fact, “we’ve seen negative job creation over the last months.”

The financial sector, for example, has not added net new positions since August. “Financial services will certainly become much less profitable in the future” as institutions continue to lower their risk exposure in the face of increased regulatory pressures. Lower profits will dampen the prospects for big job gains in one of Luxembourg’s most important sectors.

This in turn means that tax revenues will remain relatively flat while government expenditures will continue to rise out of proportion, he explained. Traditionally Luxembourg had accumulated significant budget surpluses which allowed the country to take a long-term view towards fiscal policy. With the financial crisis “these buffers have been eaten up. Now we’re in deficit. There are no buffers left and no measures on the expenditures side. There’s no real downsizing of how the central government conducts its business,” he said.

Mersch--who has been both head of the Banque centrale du Luxembourg and member of the European Central Bank’s governing council since 1998--spoke during the British Chamber of Commerce for Luxembourg’s sustaining members’ reception, which was hosted by the UK’s ambassador to the Grand Duchy, Alice Walpole.

As “GDP has not shown spectacular growth” in recent years, “political inaction is not an option,” Robert Deed, chair of the British Chamber, remarked.

Lack of reform

Yet Mersch lamented that the government’s frequently announced timelines for revamping the pension and wages systems continually slip past their intended deadlines. Luxembourg politicians’ failure to embrace reform will only exacerbate the Grand Duchy’s financial situation, Mersch commented. “It’s better to start to adjust early with smaller measures than have to take harsh measures later.”

“The pension system surplus will disappear rapidly in the coming years,” the governor added. The central bank expects economic growth of three percent “but that’s 50 percent less than the growth we had during the last 20 years.” Mersh explained that the Grand Duchy’s social system requires GDP growth of at least four percent to avoid falling into deficit.

Mersh (photo) also took on the automatic indexation of wages with inflation, which many have said is distorted by energy costs. “Our salaries are still growing faster than our productivity. Employers need to make it clear that this is not compatible with reality. We will need to have more frank discussion than we’re used to having.”

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